My Favorite Kind of Money
Let’s face it.
Money is money.
Yet there is one type of money that brings a smile to my face more than any other: Money gained from Passive Income.
It is when you are no longer a slave to money and instead it becomes your servant.
Money can be a tireless worker that earns its keep even while you are asleep without ever taking a day off.
Through the 8th wonder of the world called compound interest, the principal can exponentially grow as the money it generates can then be employed to turbocharge the system further.
I recently told my colleague that although my passive income at its current state is approximately 7% of my active income, I get far more excited cultivating and monitoring that income stream than I do the latter one.
Why is that so?
I make far more money at work then I do passively, yet it is the dollars from my passive income stream that hold my interest the longest and brings the greatest joy.
In order to fully understand what’s going on I give you an example:
- Say you are walking along a street and find and pick up a $20 bill. No matter from what walk of life you are,I think that this would still bring an injection of joy into your life.
- This is literally found money. You might view it a bit of good luck. A gift.
- I don’t know about you but I certainly would tell people about it and probably grinning while I do so. I anticipate their responses would likely be of congratulations or how lucky I was.
- Now compare that feeling of found money to getting $20 you worked for on payday. Certainly doesn’t have the same feeling does it?
- I certainly wouldn’t be telling co-workers or friends, “Guess what I got?!? $20 from my payday!!” (and if I did, I’m sure they would not be impressed at all)
- This money feels ordinary, nothing special about it. In fact the IRS classifies this as Ordinary Income (quite an appropriate term)
And therein lies the beauty of passive income.
It creates the same feelings as those elicited in found money.
Some individuals even refer to it as “mailbox money,” implying that all you have to do is open up your mailbox and collect it (to be honest with direct deposits now readily available, even this term is obsolete with now even a greater level of implied passivity).
Money from your paycheck is associated with the labor you put in to get it.
Passive income breaks that association between human capital and true capital.
This result is the invigorating feeling and endorphin rush I get when I know I’m on the right side of the money equation (lender, not borrower).
Just this phenomena alone would make passive income a true winner, however there is yet even far more greater benefits to be had:
The IRS makes a major distinction between Ordinary Income (money earned from wages, short term capital gains and interest (some may question why interest is considered ordinary income as do I)) and Passive Income (income from long term capital gains or qualified stock dividends)
This simple distinction has major tax implications, highly favoring the passive income stream.
Ordinary income from all sources is taxed using the traditional income tax tables the IRS puts out, currently at 7 brackets with the top tax rate at 37%.
Passive income greatly benefits under tax law, with a maximum tax rate of 23.8% (20% maximum rate + 3.8% for the net income investment tax under the Affordable Care Act).
The difference in taxation of Ordinary/Active income from Passive income gives an interest arbitrage of 13.2% at the highest bracket, a considerable tax savings.
Currently I break down my passive income streams into two categories:
- Non-retirement Passive Income (80% of my passive income stream at the end of 2017):
- Income generated from dividends in my taxable/brokerage account and distributions from my shares in various LLC properties.
- Retirement Passive Income (20% of my passive income stream at the end of 2017):
- Dividends from my 401k, IRA (Roth and Traditional) and Health Savings Account
I make this distinction so that I can anticipate what kind of money I would have readily available if I choose to retire early (limiting my sources to the non-retirement passive income stream) and also what money I can expect when I do reach the age of traditional retirement (combining the above two sources).
I also have two more potential passive income streams that I keep track of but do not currently include in the above calculations:
- Expected Social Security benefits
- Pension benefit I received for my employment in the radiology residency program I trained at.
I consider this “bonus money” as this may or not be there when I reach the age of qualification, briefly addressed before in a recent post.
My ultimate goal is to continue to nurture/build these passive income streams so that they can support a desired retirement lifestyle and greatly minimize, if not completely eliminate, the need to withdraw principal.
If I can eliminate the need to access the principal of these investments, I would never be at the mercy of the market and it’s volatility (especially never having to sell assets during a market downturn and locking in losses).
Super-power Take Home Points:
- Passive income is perceived far more favorably by both the recipient and the IRS when compared to Active/Ordinary Income
- The ultimate goal is to create passive income from various sources that can provide sufficient income throughout retirement.
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